Behavioral Economics: Crash Course Economics #27

Behavioral Economics: Crash Course Economics #27

Adriene: Hi, this is Crash Course Economics,
I’m Adriene Hill. Jacob: And I’m Jacob Clifford. So, when
economists make their models, they generally assume that people are rational and predictable. Adriene: But when we look at actual human
beings, it turns out that people are impulsive, shortsighted, and, a lot of times, just plain
irrational. Look! Balloons! Jacob: Today we’re talking about Behavioral
Economics and how people actually make decisions. [Theme Music] Behavioral economics is a subfield of economics
that focuses on the psychological, social, and emotional factors that influence decision-making.
That’s not necessarily new. In fact, our old buddy Adam Smith, discussed it in The Theory
of Moral Sentiments in 1759. But generations of economists chose to ignore
many irrational elements of decision making since it makes it harder to predict human
behavior. But in the last few decades, behavioral economics
has made a comeback. Several Nobel Prizes have been awarded to researchers that blend
economics and psychology and behavioral economics is being applied to more and more fields like
marketing, finance, political science, and public policy. Now it’s important to mention that irrational
human behavior doesn’t negate everything you’ve learned here at Crash Course Economics.
It just adds another layer of complexity, which is exactly what we love at Crash Course Now in most cases, people are rational. When
the price falls for a product, people have a tendancy to buy more of that product, so the law of
demand holds true. But economists also accept that there is bounded rationality. Limits
on information, time, and abilities might prevent people from seeking out the best possible
outcome. For example, if the price for ice cream is
really low consumers might not buy more. In fact, they might buy less if they think that that
low price means that ice cream tastes horrible. Now if that happens, then the law of demand doesn’t hold true, which creates a serious problem in classical economics. I mean it is the LAW of demand. You can’t
have a situation that breaks the law and still call it a law. That doesn’t happen in other
disciplines like physics…except it does. The Newtonian laws of physics, like gravity,
hold true most of the time but they break down at the quantum level. They explain the
orbits of planets, but they have a harder time explaining the orbits of electrons And It’s the same in economics. Classical
economic theories explain the big picture stuff pretty well, but there are still a lot
of things about individual decision-making that we just don’t fully understand. Adriene: In our ice cream example one of the
problems is lack of information. Classical economics assumes that consumers have perfect
information when making choices. That is, they know or at least can quickly access information
about prices and quality, but, in reality, they often don’t. Sure, the consumer could ask around or call
their friends to see if they’ve tried that type of ice cream but they’re probably not
gonna do that. In this situation, consumers may act on the limited information they have,
a suspiciously low price, which means either the ice cream is a great deal or it tastes
like mayonnaise. They just don’t know. Prices do send a lot of signals, and there’s
even science on how prices change perception. A study in California analyzed the brains
of people taste testing a variety of red wines. The researchers gave participants fake prices and scanned their brains to determine the level of enjoyment. The results were surprising. When they thought the price was higher, they actually liked the wine more. This held true even when the subjects were
given the exact same type of wine but were told it was a different higher-priced wine.
The researchers said “Contrary to the basic assumptions of economics…marketing actions
can successfully affect experienced pleasantness by manipulating non-intrinsic attributes of
goods.” So, once you’ve got a palatable Pinot Noir,
you might be able to raise the price, and actually raise the demand. All you have to
do is change perceptions. The idea that perceptions and passions
influence our actions also applies in finance. Many economists used to believe that assets, like
stocks and real estate, would stay at or near their real value because cold, calculating
investors would buy undervalued assets and sell overvalued assets. But that doesn’t
explain bubbles: In real life, investors aren’t always cold and calculating. They can get worked up and irrational sometimes. This helps explain bubbles. From the Dutch Tulip Mania
of the 17th century, to the 2008 financial crisis. Investors became irrationally exuberant,
and were driven not by logic, but by what economist John Maynard Keynes
once called, “Animal Spirits.” So behavioral economics doesn’t blow up traditional economic theory, it just seeks to understand when and why people behave differently than economic models suggest. Let’s go the Thought Bubble: Jacob: One of the most popular experiments in
behavioral economics is called the ultimatum game. In this experiment, two players decide how to
share a specific sum of money, let’s say $100. The first player is given all the money and then is asked to propose a way of splitting it with the second player. Now if the second player accepts the deal
both players get to keep the money. But, if the second player refuses,
nobody gets to keep the money. When the first player offers to split the money
50/50 the second player almost always accepts. But what happens when the first player
offers an unequal split, like 80/20? Would you accept that offer? Well, It turns out
that less equal offers are often rejected. Now that doesn’t seem surprising, but it directly contradicts classical economic theory. It’s irrational. The rational choice would be for the second
player to accept any offer, even if it’s only a dollar. After all, a dollar is better than nothing.
But human behavior is not motivated solely by gain; it’s also shaped by complex ideas like
fairness, injustice, and even revenge. The ultimatum game shows that people aren’t always as predictable as many economists like to suggest. If people were entirely rational then they
would consistently make the same decision given identical options, but sometimes people’s
preferences are dependent on how the options are presented. Psychologists call this type
of cognitive bias the Framing Effect. I mean, would you rather eat beef that’s 75%
fat free or 25% fat? Would you rather enter a raffle that claims that 1 out of every 1000
players is a winner or a raffle that points out that there will be 999 losers. Would you
support a law named the “Improve our Schools Act” or one named the “Raise our Taxes
Act”? Each of these scenarios can be framed in ways
that influence your decision. Classical economics argues that framing should have relatively
little effect on decision making because most people are rational and intelligent, but in
the real world, people can be pretty irrational. Adriene: Thanks Thought Bubble. So, Businesses
have known about the psychology of decision making for a long time. For example, a gym
might break down its membership fee and advertise it only costs only $1 a day, which seems
way more affordable than $365 a year. And a TV priced at $499.99 seems like a
better deal than one priced at $500. This is called psychological pricing. It can
make people feel like they’re getting a good deal. Interestingly, high-end retailers sometimes
do the opposite. They set their prices at whole dollars, basically signalling their goods are of a higher quality than you might see at a discount store. Behavioral economists also like to talk about
nudge theory. Nudges encourage people to act a certain way, without actually changing the
choices that are available to them. Fighting childhood obesity is a priority in
many countries and policy makers have suggested a whole range of solutions. Everything from
banning soda in schools to running media campaigns promoting healthy eating. Behavioral economists
approached the problem a little differently. They wanted to see if they could get children
to eat healthier by rearranging school cafeterias. They put healthier food like fruits and vegetables
on eye-level shelves and less healthy foods, like desserts, in less convenient places.
Classical economic theory suggests that this idea wouldn’t work since rational people
would pick the brownie. But it turns out, students choose the healthier foods.
Nudge theory works and it’s changing how we implement public policy. There are some issues that
can be addressed best with the right type of nudge. Jacob: Let’s talk about something else behavioral
economists look at: risk. Let’s say someone offered you two sealed envelopes. One has
a hundred dollars, and one has no dollars. You can choose an envelope, or you can
take $50 cash right now. So do you take the fifty bucks?
Or what about $49? Now, this is unlikely to happen to you in
real life, but the exercise is about your attitude towards risk. Since there’s a 50/50
chance of getting $100 or nothing, the expected return, or the average of the possible outcomes
is $50. If you’re willing to accept $50 cash to
abandon the envelopes, then you’re risk neutral. But If you accept less than $50, just to avoid walking away with nothing, then you’re risk-averse. Behavioral economists have done lots of studies
about risk and in particular loss aversion, the idea that people strongly want to avoid
losing. Studies show that, in general, losses are more painful than gains are pleasurable.
So people might choose a safe course of action even if it’s not the most logical choice. Let’s say we flip a coin and if it’s heads I give you $100 but if it’s tails, you have to give me $50. Now, mathematically you should go for it. But many people won’t because they want to avoid losing. Adriene: Understanding of loss aversion can help businesses and policymakers influence decisions. For example, some grocery stores
in the Washington DC tried to decrease the use of disposable plastic bags by offering five cent bonuses if customers brought reusable bags. The policy didn’t do that much. Later they
tried a five-cent tax on plastic bags, and, this time, people used fewer disposable bags.
This is loss aversion at work. The pain of having to pay 5 cents per bag was greater
than the benefit of receiving 5 cents per bag. Another study analyzed how loss aversion can
help incentivise employees. Researchers divided workers into three groups. The first was a
control group that wasn’t given a bonus. The second group was promised a bonus at the
end of the year based on meeting specific goals. Participants in third group were given the
bonus at the beginning of the year and were told that they would have to pay it back if
they didn’t meet specific goals. The workers in the first and second groups
performed about the same. But those in the third group performed
significantly better. We just hate losing. Jacob: So, behavioral economics has a lot
to tell us. Accounting for emotion gives us a realistic view of how people actually
behave. Adriene: We might not always be the rational
actors classical economists believe us to be. For years, economics has had a blind spot.
But behavioral economics helps us get a better look at how we make decisions. Thanks for watching. We’ll see you next
week. Jacob: Thanks for watching Crash Course Economics.
It’s made with the help of all these awesome people. You could help keep Crash Course free, for
everyone, forever, by supporting it at Patreon. Thanks for watching. DFTBA.

100 thoughts on “Behavioral Economics: Crash Course Economics #27

  1. Your icecream example is completely wrong. The demand curve only holds for an individual product and its changes in quantity demanded given a price. What you are describing is price as an indicator of quality, which serves to discriminate between different products, but if you have a particular icecream and its price falls, that tells you absolutely nothing about its quality.

  2. You should have mentioned that people reacted very differently in the ultimatum game depending on cultural influences! Not only do economists have a gap of knowledge with behavior, they have a gap of knowledge of the behavior of anyone outside of North America.

  3. What about a gym membership that is only $15 a month, but hidden in the contract is a quarterly $45 maintenance fee? Still approx a $1 a day. Love it when people gloat how cheap their membership is, when they don't consider the true cost.

  4. the group with promised bonus didn't perform better because it's right thing to do. I get punished couple of times in my life by believing companies promises, I don't do it anymore as well. If participants would be kids they would perform better, because of lack of experience.

  5. This is a nice summary, but the term "irrational" and "rational" is used in a pretty loose way that does not correspond to the way it is used in economics. The ultimatum game does not show any kind of irrationality, but only that people care about more than money (which you said, but still called it irrational). It also does not contradict any economic axioms.

  6. I get the feeling Crash Course Economics is a big fan of Prof. Robert Shiller of Yale. He is a pretty cool dude, though. Look him up people!

  7. Here is the key: the value of an asset is what you expect the next person would pay for it. I'd buy a beat-up Honda Civic for $5k if I know I could sell it for $6-7k. This applies regardless of the intrinsic value of the object.

  8. Great video
    I'm currently doing my master's degree which relates to behavioral economics, and it would be awesome if you can provide us with the references you used to create the video
    so we can read more about it 🙂

  9. In one dimension ice cream had flies in it. it was a measure to end the human- giant spider wars. all Ice cream there is for all beings, no matter how many legs.

  10. Curious, in the 3 groups bonus experiment, won't it have a negative impact on morale for the 3rd group? So while it might work out in the short term, I'd expect a higher quit rate for the third and perhaps degradation of performance over time.
    Granted, I understand the point you are trying to make. But I'd rather not people see this and try to apply it only to be adversely affected later.

  11. Consumers don't seek more information? This is an illustration of opportunity cost, for time spent seeking more info is time that could be spent elsewhere (like watching YouTube videos on economics☺).

  12. And that's why people buy iPhones even when it's an expensive piece of junk.
    They are snobbishly irrational.

  13. When discussing rationality in YouTube comments, make sure to keep in mind that it's not conventional rationality or logic that is being referenced in these discussions. It's simple logic, meaning a>b and b>c, so a>c. Don't go into discussions based on your ideas of common sense or rationality.

  14. So, in a way, classical economics is like classical physics as in that it explains the COLLECTIONS of instances, the combined effect, the big picture. Whereas behavioral economics is like quantum physics, as in that it deals with individual instances, that may be difficult or impossible to predict.

  15. The main points :
    1.Bounded rationality🧠
    2.Lack of information🤷
    3.Manipulate non interinsic attributes of price💝
    4.Framing effect💍
    5.Psychological pricing👨‍🏫
    6.Nudge theory😕
    7.Risk(neutral & averse)🤑<😓

  16. Bubbles can not be explained with irrationalities. Even Tulipmania was created due to expected capital gains, not because tulip looks gorgeous (though i do think tulips look stunning). The term bubble often gets misinterpreted with irrationality, but it is caused by perfectly rational choices. Economic irrationality could cause people to turn up on election date, while they don't appear in general meeting of the share they hold (It is extremely hard to change president by voting a person. Also, it is really hard for a politician to have completely different policy, due to democracy).

  17. Classical economic theory still holds true for most of the phenomenons explain in this video. Framing is the instance for which further deliberation from my end is needed.

    Take for instance risks, and let us assume a utility function as follow:

    f(x) = x*p ; where x = cash and p = probability

    1. You can indeed take the 50/50 bet of obtaining either $100 or $0.
    2. Otherwise, you can simply opt to receive $50.

    The expected utility for both options is $50 as (easily) proven below.
    f(100) = 100*.5 = 50
    f(50) = 50*1 = 50

    What this video tries to illustrate is that if you were instead given the choice between
    {1. You can indeed take the 50/50 bet of obtaining either $100 or $0.
    {2. Otherwise, you can simply opt to receive 50>n
    and you decided to choose the second option, you are an irrational consumer because your expected utility would be less than 50.


    Economics teaches us that individuals can obtain or lose utility from anything. In this case, we can adjust our initial equation by including the utility humans may get from certainty (indeed, this is implied, but reasonable nonetheless).

    If we input such benefit someone may get into the equation, we can end up with an equation as such:

    f(x) = x*p + 10*p

    Note: the number 10 is hypothetical and should be determined on an individual basis.

    The new equation depicts that this specific individual obtains more utility from certainty (aka more probability of getting money), and can gain up to 10 units of utility.

    Under this new model that takes into account the utility a person gets from certainty, the rational decision is to choose the $50 payout.

    f(50) = 50*1 + 10*1 = 60 > f(100) = 100*.5 = 50

    Yet again, microeconomics is truly based on implications and the rationale behind it will never mirror the world we tread. Hope this provoked some thought and changed the way you perceive decision making.

  18. I don't see how the ultimatum game points to irrationality. Isn't the idea of iterated games a solid reason to refuse an unfair split? Even if the CONTESTANTS will never see each other again, it makes a lot of sense that we are WIRED UP to value long-term fairness over immediate, short-term gain because one-time, non-iterated games are nearly non-existent in the real world. There are always going to be additional consequences to choices in the real world, outside of a vacuum. This is the reason the prisoner's dilemma is so confusing. In a vacuum, defecting is always the dominant strat, but if you iterate the prisoner's dilemma the dominant strategy becomes cooperation.

  19. Is it ever too late to go back and get a degree in economics? I'm an engineer but am also in my 30's? Would that be too old for someone to allow me to do research?

  20. Some say we make irrational decisions to retain our identities as human beings, that irrational behaviors developed long long prior to the rational ones. Maybe we are behaving "irrational" also because we value "irrational" behaviors🤔.

  21. The experiment of choosing between envelope and money is definitely about risk, but not really about money. It's about the expected utility of money. Talking about "risk perception" without mentioning utility is incorrect and misleading.

  22. Classical economics operates mostly on 'ceterus paribus', but as the world become more complex, more factors can't be ignored and multiple theories emerged into new understanding (Complexity Theory)

  23. Bottom line as with my Industry Landscape Architecture and Urban Design, 'Its about people…stupid'. I spend so much time talking to clients about just people and their often irritational, emotion based ways, with all the present cognitive research we can actually improve the experience of the majority by small nudge changes, the classic being desire lines….

    A really excellent video…this type of behavioral science needs to be at the centre of more industries to avoid a seemingly rational expectation to an often irrational end user.

    This is a huge subject as we have the nature, nurture, environment, expected cultural rules, length of time for a decision, empath or sociopath and everything in between….

    It's ultimately not about boxes, but evolution and a framework to be adapted as we evolve, messy sometimes for sure, but a lot less damaging than dictact's from above….

  24. If you raise the price of a product and that make it sell more, that means you increase the demand of one sector of the population that wasn't interest before, meaning the law of supply and demand it's still a law.

  25. Yeah I'm that analytical customer where framing doesn't work. In fact, if you don't give me all the details, I'll ask for them anyway. If they are not provided, the transaction most likely will not complete. I think the problem these days is that the framing that is done today isn't as honest as the examples provided. Many times the framing provided is not even based in reality. It's fantasy for sale. But I guess the thinking is if they can convince the customer that the fantasy is plausible then the sales person wins. The problem is analytical customers who realize what is being done because they also understand sales and framing, they become increasingly skeptical and less trusting.

  26. A thought: the whole question on price depends on our value system, i.e. what we value in life. for people who has the money, we will value quality or ideology more. eg. the $50 vs envelope question, Depending on your income. If my earning per week is $100 it is likely i will take $50 with certainty; if i earn $1000 per week, doesn't really make a huge difference, perhaps i will give $100 a try? if i am a billionaire, probably match it 10 times and give it to a charity, to create a good name for myself. Demand increases while price drops is a simple model. But perhaps we could consider all these factors and their correlation, and then put them into a model to predict the demand?

  27. I would inquire about the protocol of the wine testing research. Wine testing can be influenced by factors other than $.

  28. Can someone give me a link to the wine study ? I have a presentation soon and I’ve been searching on my university database but I can’t find the study. Thanks in advance

  29. I didn’t agree with the coin flip. Everyone would go for it or at least most people will. If it was 50/50 fair enough but it’s 50/100

  30. Woahhhhh…! That Newtonian physics example was way off! Newtonian gravity explains the movement of regular-scale objects, but when it comes to massive objects e.g. stars, black holes, it breaks down and you need Einsteinian (relativistic) gravity. Meanwhile, gravity has nothing to do with the orbits of electrons.

  31. Arguably 7:29 supports cost/benefit thinking because in the experiment, food that's less convenient to reach requires more effort to get which could be considered cost. The food that is easier to reach and therefore has less "cost" seems to be more popular.

  32. Arguably 7:29 supports cost/benefit thinking because in the experiment, food that's less convenient to reach requires more effort to get which could be considered cost. The food that is easier to reach and therefore has less "cost" seems to be more popular.

  33. Classical economics assumes everyone is rational and behavioral economics just assumes everyone is stupid and needs to be protected from stupidity by using regulations. Much rather have the freedom that comes with the classical

  34. How is the CC Angry Mongolian not an internet meme by now?? It can rival the Family Guy Evil Monkey.

    If I just demand the CC Angry Mongolian memes surely this channel will provide the supply 🤪🤷

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